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SEC seeks investor protections related to SPACs and shell companies
On March 30, the SEC proposed rules and amendments regarding special purpose acquisition companies (SPACs), shell companies, and projections disclosure. The proposed rules are intended to enhance investor protections in initial public offerings (IPOs) by SPACs and in subsequent business combination transactions between SPACs and private operating companies. The proposed rules will also address the treatment under the Securities Act of 1933 of business combination transactions involving a reporting shell company and amend the financial statement requirements for private operating companies applicable to transactions involving shell companies. Additionally, the SEC proposed “specialized disclosure requirements with respect to, among other things, compensation paid to sponsors, conflicts of interest, dilution, and the fairness of these business combination transactions.” The SEC issued a corresponding Fact Sheet recognizing that the rapid increase in the number of SPAC IPOs over the past two years has “heightened investor protection concerns” and raised questions as to whether certain SPACs may be investment companies subject to the requirements of the Investment Company Act. The proposed rule also includes a new safe harbor designed to “provide that a SPAC that satisfies the conditions of the proposed rule would not be an investment company and therefore would not be subject to regulation under [the Investment Company Act].”
“[I]f adopted, [the proposed rule] would strengthen disclosure, marketing standards, and gatekeeper and issuer obligations by market participants in SPACs, helping ensure that investors in these vehicles get protections similar to those when investing in traditional initial public offerings,” SEC Chair Gary Gensler said.
Comments on the proposed rule are due 60 days following publication of the proposing release on the SEC’s website or 30 days after publication in the Federal Register, whichever is later.
SEC: Offshore issuers must disclose relationships to China-based operating companies
On July 30, SEC Chair Gary Gensler issued a statement instructing staff to seek certain disclosures from China-based operating companies and offshore issuers associated with such companies before their registration statements can be declared effective. Gensler explained that the Chinese government recently provided “new guidance to and placed restrictions on China-based companies raising capital offshore, including through associated offshore shell companies.” This is relevant to U.S. investors, Gensler stated, because a number of Chinese sectors restrict companies from having foreign ownership and prohibit them from listing on exchanges outside of China.
In order to bypass these restrictions, many China-based operating companies are structured as Variable Interest Entities (VIEs), where they establish an offshore shell company in another jurisdiction, such as the Cayman Islands, to issue stock to public shareholders, Gensler said. He expressed concerns that the average U.S. investor “may not realize that they hold stock in a shell company rather than a China-based operating company,” where the investors’ “exposure” to the Chinese company is derived only through a series of contracts between the shell and the operating company, with neither the investor nor the shell company holding any equity in the Chinese company itself.
In light of the overall risks associated with the China-based VIE structure, Gensler asked staff to ensure that offshore issuers associated with China-based operating companies prominently and clearly disclose (i) that investors are buying shares of a shell company issuer; (ii) that “investors face uncertainty about future actions by the government of China that could significantly affect the operating company’s financial performance and the enforceability of the contractual arrangements”; and (iii) the financial relationship between the VIE and the issuer. In addition, for all China-based operating companies seeking to register securities with the SEC (either directly or through a shell company), Gensler asked staff to ensure these companies disclose, among other things, whether the company and the issuer received permission from Chinese authorities to be listed on U.S. exchanges, as well as the risk that an approval could be denied or rescinded. Gensler further noted that China-based operating companies may be delisted in the future if the Public Company Accounting Oversight Board is unable to inspect an issuer’s public accounting firm within three years, as required by the Holding Foreign Companies Accountable Act.